Good Riddance to a Bloody Year

W hy is it so easy now for most people to laugh at the triple-digit price-to-earnings share multiples prevalent back in the spring? Because it would hurt if they didn't.

The fulcrum for the awful European equity market performance this year came in the first few days of March, the headiest perhaps since before the 1987 crash. Last spring, prospective years of red ink mattered little in a technology's stock valuation, while a track record of profits mattered not at all if you were a grungy Old Economy company. In the five months from mid-October 1999 to early March 2000, for example, the Dow Jones Stoxx pan-European index of 600 companies jumped 37%. Technology and media stocks led the charge with a 150% rise over that period, while telecom shares more than doubled. Chemical-firm shares, by the way, gained about 4%.

The Continental crescendo, according to Marcus Smith, a portfolio manager with MFS, had to be the day in early March that saw
France Telecom
's market capitalization catapulted by about 45 billion euros -- roughly the equivalent of adding
Ford Motor
-- in a matter of hours. Why? The company said it was considering a public offering of its Internet service provider and its cellular-phone arm. Within days, the Nasdaq, to which a number of European markets are highly correlated, reached its all-time high.

When it came to the Internet sector, "people thought it would be possible to create value in 2010 with 10 years of losses," notes Jean Charles Meriaux, Paris-based head of European equities for LCF Rothschild Asset Management. "Stock market valuations were completely crazy. P/Es moved to more than 100 times on the basis of a number of clicks," he says derisively. "That business plan didn't work. It was a collective error by the market," he adds, in what might be the understatement of the year.

Investors, particularly professional money managers, should have exhibited more skepticism. "We all knew the valuations were hitting excessive levels. But the music was so good and wine was flowing and you didn't want to leave the party," says a wistful Sanjay Jhaveri, a portfolio manager at Vontobel Asset Management in Zurich. "We were all guilty of focusing on relative instead of absolute valuations. As a money manager, if you weren't overweight in tech, you were just bleeding."

The trigger for the downfall? No doubt there's more than one, especially since global stock markets are now joined at the hip. Yet, if one had to pinpoint when the European bubble was pricked, it would have to be the U.K. auction for third-generation wireless spectrum, which began March 6, says MFS' Smith. By the time it ended one month later, the British government had extracted some $34 billion from the European telecom industry just for five licenses in one country. The infrastructure was going to cost many billions more to build, and the German, French and Italian auctions were still to come.

The Internet bubble likely would have burst anyway, but in Europe, where cell phones are more prevalent than PCs, the kind of seed money it was now going to take for the yet-to-be-proven 3G wireless service could not be ignored, not even during a raucous party. It finally hit home and telecom stocks deflated, followed quickly by media and technology stocks.

Now, in truth, the broader European markets aren't down all that much on the year. The Dow Jones pan-European index is down about 7% as of last Friday. And it's down only about 13% from its high of 405.50 on March 6, nothing like the Nasdaq's crash. For U.S.-based investors, things are worse: the index is down 16% in dollar terms.

But 2000 will be the first down year since 1994. More importantly, most TMT stocks -- the group that many take as the bellwether for Europe's future growth -- are down 40%-50% and more from their highs. Consequently, the real damage has been to the market's psyche. The Internet's power to transform businesses is real, and the cell phone is the best way to reach most Europeans. But in the future, businesses in those sectors will have to jump through many more hoops before getting their investments funded.

For all the misery this year, it's worth remembering that the market has been unusually generous in the last half-decade. The DJ Stoxx pan-European index has risen a whopping 182% over the last six years. It finished at 353.12, down 2.4% on the week in thin trading.

I n an effort to lighten up an otherwise dismal year, this column begins its first annual European Shareholder Booby Awards, or the "ESBAs."

The Build It and We'll Figure Out How to Sell It Later prize for throwing away shareholder money goes to the European telecom industry. Nearly all the major incumbents are proposing to invest scores of billions of dollars to build a 3G cell-phone infrastructure over the next two to three years, the return on which is anything but assured.

The Build It and We Don't Care What Happens Later award goes to the tech companies like
Nokia
,
Alcatel
,
Ericsson
, and
Nortel
, among many others, which are happy to sell-to paraphrase V.I. Leninthe rope with which many telecoms firms may one day hang themselves.

The Doing Very Little Different From Six Months Ago But Suddenly Much More Popular ESBA goes to pharmaceutical, food and beverage firms, whose profit growth for the most part remains lackluster, but whose valuations are now stretched, thanks to an inflow of money that has nowhere else to go.

There are individual awards, too, for single bonehead actions. First place here is a tie between the German government and European Central Bank head Wim Duisenberg. Last summer, the former ordered retailer Wal-Mart to raise prices, thereby showing its true concern for the long-suffering German consumer, while the latter's loose lips in October about the ECB not intervening to help the euro sent the currency to new lows.

There were a couple of momentous events for the better, as well.
Vodafone
's takeover of Mannesmann showed that big cross-border mergers in Europe could get done and that shareholders were to be respected. And the German government gets kudos this time for passing capitalgains-tax reform that will unwind the myriad share cross-holdings in German industry.

F or all the gloom, there is a ray of hope that belongs only to Europe. That's the euro, which continues to gain ground on the U.S. dollar and the Japanese yen. Last week, the euro finished at about 92.45 U.S. cents, nearly a five-month high.

The currency's bounce from lows of about 82 cents and 89 yen in late October can be attributed to the problems suddenly afflicting the dollar, notes Niels Christensen, a Paris-based currency analyst with Societe Generale. In particular, support for the euro comes from the narrowing differential between economic growth in Europe and the U.S. and between their respective interest rates, he says. The higher rates in the U.S. will likely be moving down soon toward European levels, and that should diminish or reverse investment capital flows that had been heavily in the U.S.'s favor all year.

Other factors include lower prices for crude oil, which trades in dollars; the continuing wide U.S. trade deficit; and uncertainty over the policies of a new Treasury Secretary in the U.S., all of which weigh on the dollar. "These are all positives for the euro," adds Christensen.

Riad Younes, a portfolio manager at Julius Baer, says that the embattled common currency should strengthen next year up to 20% from the lows. "With the investment flows out of U.S. technology stocks and little or no differential in economic growth rates, people will refocus on the deficit. Parity by yearend [2001] is possible," he asserts.

T 'was the night before Christmas, and all through the land, not a banker was stirring, not even Greenspan. The markets were stung by exuberance and bears, And hope rang eternal that St. Alan still cared. The short-sellers, nestled by stocks in the red, Thrilled as delusions of chaos danced in their heads, And Dubya in his fog, a pump-primer in lap, Had just settled himself in for a nice four-year nap. When out on the Nasdaq, there arose such a blather, Bush sprang from his bed to see what was the matter. Rate cuts a-comin' on the new-fallen dough, Gave the luster of hope to the stocks down below. When to Dubya's wondering eyes came such luck, What ho, a miniature Fed and eight tiny rate cuts, With a little old rate driver, sans smile and elan, He knew in a moment it must be St. Alan. Faster than a plunging Red Hat, subliminable they came, And he yelled and pouted, and on them pinned the blame, Now, Slowdown! Now, Inflation! In Booms we do trust! On Job Growth! Productivity! On Yonder or Bust! To the top of the market, make haste 'fore we fall, Recession away, recession away, recession away all!

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